Industrial Economics and

Foreign Trade
Module 4 – Part 1 National Income –
Circular Flow
By
Dr. Johnson T T
Assistant Professor in Economics
CET
Mob. 9447450408
The Circular flow of Income
Economic transactions generate two types of flows i) Product flow or real flow and ii) money flow. In the economy
products and money flow in opposite directions in a circular manner. This is called circular flow of income.

To illustrate the flows of income and expenditure, an economy is divided into four sectors- i) Household sector ii)
Business sector or firms iii) government sector iv) Foreign sector.

Circular flow in a two sector model

In a simple two sector model the two sectors are households and firms. Households possess all factors of production.
They supply these factor services to firms and get factor payments in the form of rent, interest, wages and profit. This
income is spend for buying goods and services produced by firms.
Two sector model with capital market
Three sector model
Circular flow in a four sector model
 Industrial Economics and
Foreign Trade
Module 4 – Part 2 National Income -
Concepts
By
Dr. Johnson T T
Assistant Professor in Economics
CET
Mob. 9447450408
Factor income and Transfer income
Factor income is the income received for supplying a factor service.
Transfer payments are unilateral or one sided payments

Intermediate goods and final goods

Goods which are used in the production of other goods and services are called intermediate goods.
Goods which are ready for consumption or investment are called final goods.

Consumer goods and capital goods

Goods which are used for consumption purpose are called consumer goods
Goods which are used to produce other goods and services are called capital goods.

Stock and Flow

Stock is the quantity of a variable measured at a point of time.
Flow is the quantity of a variable measured over a period of time
National Income
National income can be defined differently. From the income side it is the sum total of the factor incomes received by the
residents of a country in the form of rent, interest, wages and profit over a period of one year.

Gross Domestic Product at Market Price(GDPmp)

It is the money value of all final goods and services produced within the domestic territory of a country during a
financial year

Net Domestic product at market price(NDPmp)

NDPmp = GDPmp – Depreciation.
Depreciation is the loss in the value of capital assets due to wear and tear during production.

Net National Product at market price (NNPmp)

NNPmp = NDPmp + NFIA
A country get factor income in the form of rent, interest, wages and profit from other countries. At the same time factor
payments are made to other countries for making use of their factor services. The difference between these two is called
NFIA.
Net National Product at factor cost (NNPfc)
NNPfc = NNPmp – Net Indirect Tax(NIT)

NIT = Indirect Tax – Subsidy

NNPfc is the national income of a country

Gross National Product (GNP)

GNP is the money value of all final goods and services
produced in a country including net factor income from abroad.

GNP = GDP + NFIA

Private Income
Private Income refers to income of non-governmental entities from all sources over a period of one accounting year

Private Income = NNPFC – domestic product accruing to the government sector +

transfer payments + Interest on public debt

Personal Income
It is the income of the household sector from all sources before paying direct taxes in a financial year.
Personal income (PI) ≡ National Income – (Corporate tax + Undistributed corporate profits + social security
contributions) + Transfer payments + interest on public debt

Personal Disposable Income

It is defined as the part of personal income left for consumption and saving after the payment of taxes.
Personal Disposable Income = Personal Income – Direct taxes
Per capita income
It is the income per head. In other words it is the average income of the people of a country in one year. It is obtained
by dividing national income by population.

Per capita income = National Income

 Industrial Economics and
Foreign Trade
Module 4 – Part 3 National Income
– Measurement of National Income
By
Dr. Johnson T T
Assistant Professor in Economics
CET
Mob. 9447450408
Measurement of National Income
There are three important methods of measuring national income. They are

1. Product method or output method

2. Final Expenditure method
3. Income method

Product method or output method

Under this method GDP is estimated as the sum of the money value of all final goods and services produced
in the domestic territory of a country during a financial year. The following are the important steps involved
in the estimation of GDP

i) Identifying the production units and classifying them under respective industries and each industry under
the corresponding sector.

ii) Estimate the value of final output produced by each production unit, each industry and each sector.(Gross
value of output of a production unit = P*Q where P is the price per unit and Q is the number of units of
output produced in a year)

The sum of value of output produced by all the three sectors gives GDPmp. That is

ΣGVOmp = GDPmp Once GDPmp is estimated we have to derive NNPfc (NI)

However this method has the problem of double counting. Double counting means counting the value of a product more
than once. This difficulty arise because final product of one firm becomes the intermediate product of another producer.
Double counting leads to overestimation of national income.
This problem can be solved by using the value added method.
Under the value added method instead of taking the value of output the gross valued added by each production unit is
estimated. Gross value added is the difference between the Gross value of output and intermediate consumption.

Gross Value Added at market price(GVAmp)= GVOmp - Intermediate Consumption

ΣGVAmp = GDPmp

Final Expenditure Method

This method estimate GDP by adding the final expenditures in the economy. There are four major components of final
expenditure
i)Private final consumption expenditure(C)
ii) Investment Expenditure (I)
iii) Government consumption expenditure (G)
iv) Net exports ( X-M)
When these four items are added we get GDPmp. That is

C+I+G+X-M = GDPmp Once GDPmp is estimated we find NNPfc or national income.

Income Method
Income method take the sum of the factor incomes in the economy. Factor incomes are

i) Rent(R) –

ii) ii) Interest(I) –

iii) iii) Wages (W)–

iv) Profit (P)–.

v) Mixed income of the self employed.

When these five items are added we get NDPfc.

R+I+W+P+ Mixed income = NDPfc

NNPfc = NDPfc + NFIA

Items excluded from national income estimation
1. Buying and selling of shares and securities. 2. Value of intermediate goods used. 3. Prize money from lottery.

4. All transfer payments. 5. Purchase and sale of second hand

6. Income from illegal activities like smuggling, gambling etc

Uses or significance of national income estimation
• To evaluate the performance of the economy over the years
• For economic planning and for the formulation of economic policies
• To understand the contribution of each sector towards national income
• To make comparison between the economic performance of two countries
• To measure the inequalities in the distribution of income

Difficulties in the measurement of national income

Conceptual difficulties
1. Service without remuneration. [Link] of goods as intermediate goods and final goods
3. Difficulty in estimating the value of output produced in the government sector.

Practical difficulties

1. Inadequacy of statistical data. 2. Illiteracy of farmers- 3. Lack of occupational specialisation

4. Production for self consumption- 5. Existence of a non monetised sector
Industrial Economics and
Foreign Trade
Module 4 – Part 4 Inflation
By
Dr. Johnson T T
Assistant Professor in Economics
CET
Mob. 9447450408
Inflation- Meaning and Types
Inflation is a situation in which there is a persistent rise in the general price level.
According to Coulborn it is a situation in which “too much money chasing too few goods.
When there is inflation value of money decreases persistently.

. Based on the rate, inflation can be classified as Creeping, Walking, Running and Galloping Inflation.
Demand Pull Inflation and Cost Push Inflation
Demand pull inflation is the result of an increase in aggregate demand in the absence of an increase in aggregate supply
or a relatively less increase in aggregate supply.
Once the economy reaches in full employment level any further increase in aggregate demand will lead to price rise
without any increase in output.
Cost push inflation is the result of increase in cost of production.
Causes of Inflation
Causes of inflation can be classified under demand side causes and supply side causes.

Demand side causes

i) Increase in money supply–

ii) Increase in disposable income-

iii) Increase in government expenditure –

iv)Deficit financing –
v. Cheap money Policy –

vi) Increase in population

Supply side causes

i) Shortage of capital and other complementary factors

ii) Increase in wages – iii) Speculative hoarding – iv)Natural calamities –. v) Increase in exports –.
vi) Industrial disputes
Effects of Inflation
Effects of inflation can be studied under

1. Effects on distribution of income 2. Effects on investment and production 3. Social and political effects.

1. Effects on distribution of income and wealth

a) Debtors and Creditors- b) Salaried classes and wage earners c) Investors d) Businessmen
2. Effects on investment and production
3. Social and Political impact

Measures to control inflation

There are three important ways in which inflation can be controlled.
1. Monetary policy measures
2. Fiscal policy measures 3. Other measures
1. Monetary policy measures
These are the measures adopted by the central bank of a country to control credit and money supply in an economy.
Price stability and economic growth are the two main objectives of monetary policy. Monetary policy measures can be
classifies as
a) Quantitative credit control measures b) Selective or qualitative credit control measures
Quantitative credit control measures
Quantitative controls aim at regulating the overall volume of bank credit, without considering purpose for which credit
is used .

i) Bank Rate Policy – The Bank rate is the rate at which the central Bank rediscount approved bills of exchange.

ii) Reserve Ratio There are two types of reserve ratios:

Cash Reserve Ratio(CRR)-Every commercial bank should keep a certain percentage of their total deposits(net demand
and time deposits) in the central bank in the form of cash reserve. This is mandatory and this percentage is called CRR.

Statutory liquidity ratio (SLR) – A commercial bank should keep a certain percentage of their total deposits in the
form of safe and liquid assets such as unencumbered government securities, cash and gold

While reserves under CRR is kept in the Central Bank, under SLR it is kept in the commercial bank itself. Further, while
CRR is cash reserves, SLR can be in the form of cash, gold or securities.

iii) Open Market Operations -Open market operations means the sale and purchase of government securities and
bonds by the central bank.

Selective or Qualitative credit control measures

Under this method, extension of credit to essential purposes is encouraged and to non-essential purposes is discouraged.
i) Margin Requirements – ii)Regulation of Consumer Credit – iii) Moral suasion –iv) Direct action
2. Fiscal Policy measures
These are the measures taken by the government to control the aggregate demand in the economy. The main
instruments of fiscal policy are i) public revenue ii) Public expenditure iii) Public borrowing
i) Public revenue – ii) Public expenditure – iii) Public borrowing –
3. Other measures
Other measures include the measures taken by the government to
a. increase the supply of goods and services
b. price control
c. wage control etc.
Repo rate and Reverse repo rate
Repo rate is the rate at which RBI provides overnight liquidity to banks against the collateral of government and
other approved securities.

Reverse repo is the rate at which the RBI absorbs liquidity on an overnight basis from commercial banks. In other
words, when a commercial bank has excess funds, they can deposit the same in central bank and earn interest in the
form of reverse repo rate.
Industrial Economics and
Foreign Trade
Module 4 – Part 5 Business
Financing
By
Dr. Johnson T T
Assistant Professor in Economics
CET
Mob. 9447450408
Sources of Capital

i) Internal Self-Finance ii) Equity, Debentures and Bonds: iii) Public Deposits:
iv) Loans from Banks: v) Indigenous Bankers: vi) Development Finance Institutions:

Shares and Bonds

When companies want to raise capital, they can issue Shares or bonds.
A share is a stake in the ownership of a company. Bonds are a loan agreement that a company enters into with the investor
Bonds Shares.
The investor lends money to the company The investor owns part of the company

The Issuers of bonds are Govt. institutions, financial institutions, companies, etc. Shares are issued by corporate enterprises

Risk is relatively low Risk is very high

Bond holders get Interest, as a fixed payment Shareholders get dividend, which is not guaranteed

Return is certain Return is uncertain

As bondholders have a higher claim on assets, investors may still recover some of their initial When a company is declared bankrupt Stocks will become worthless and investors may lose 100%
capital of their capital

The amount of capital the investor gets back depends on the share price when the stocks are sold.
The capital is paid back in full to the investor at maturity

Maturity period is fixed No maturity period for shares

Money market and Capital market
A financial market deals with financial assets such as stocks, bonds, treasury bills, currencies etc.

Money market
Money market deals with short term financial assets, that is, assets up to a maturity period of one year.

Functions of money market

The following are the important functions performed by the money market.
1. Financing trade –
2. Financing Industry –
3. Profitable Investment -
[Link] Mobility

5. Economic growth

Capital Market
A capital market deals with long term financial assets. In other words a capital market is a financial market in which long-
term financial assets are bought and sold. A capital market is broadly divided into two major categories: Primary Market
and Secondary Market. A market where fresh securities are offered to the public for subscription is known as Primary Market
where as a market where already issued securities are traded among investors is known as Secondary Market.
Functions of capital market
1. Allocative function- 2. Encourages Saving- 3. Encourages Investment – 4. Promotes Economic growth.

5 Indicative Function– 6. Liquidity function –

Major differences between Money Market and Capital Market

The following are the important difference between money market and capital market
1. The place where short-term marketable securities are traded . Capital Market, long-term securities are created and
traded.
2. Capital Market is well organised which Money Market lacks.
3. The instruments traded in money market carry low risk, but capital market instruments carry high risk.

4. Capital Market Instruments give higher returns as compared to money market instruments.

5. Maturity of Money Market instruments is one year or less, but Capital Market instruments have a life of more than a
year as well as some of them are irredeemable in nature.

6. Money market is unsystematic in nature where as a capital market is systematic in nature.

Stock market
The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and
issuance of shares of publicly held companies take place. Stock market is an institution which provides a platform for
buying and selling of existing securities.

A stock market is a similar designated market for trading various kinds of securities in a controlled, secure and
managed environment. Since the stock market brings together hundreds of thousands of market participants who wish
to buy and sell shares, it ensures fair pricing practices and transparency in transactions.
The following are some of the important functions of stock market.
• Providing Liquidity and Marketability to Existing Securities:
• Pricing of Securities:
• Safety of Transaction:
• Contributes to Economic Growth:
• Spreading of Equity Cult:
• Providing Scope for Speculation:
NSE
The National Stock Exchange of India Limited (NSE) is the leading stock exchange of India, located in Mumbai. NSE
was established in 1992 as the first dematerialized electronic exchange in the country. It is the world's 10th-largest stock
exchange according to May 2021 data. It was recognised as a stock exchange by SEBI in April 1993 and commenced
operations in 1994. In February 2000, the NSE started an Internet trading system.

BSE
BSE (formerly known as Bombay Stock Exchange) was started in 1875. However, in 1850s, five stock brokers gathered
together under a Banyan tree in front of Mumbai Town Hall. The brokers group became an official organization known as
"The Native Share & Stock Brokers Association" in 1875. BSE is Asia's first & the Fastest Stock Exchange in world with
the speed of 6 micro seconds and one of India's leading exchange groups.

STOCK EXCHANGE INDICES

Stock market indices are the barometers of the stock market. They mirror the stock market behaviour. With some 7,000
companies listed on the Bombay stock exchange; it is not possible to look at the prices of every stock to find out whether
the market movement is upward or downward.

NIFTY
NIFTY is a market index introduced by the National Stock Exchange. It is a blended word – National Stock Exchange
and Fifty coined by NSE on 21st April 1996. NIFTY 50 is a benchmark based index and also the flagship of NSE, which
showcases the top 50 equity stocks traded in the stock exchange out of a total of 1600 stocks.
SENSEX
The BSE SENSEX (also known as the S&P Bombay Stock Exchange or Sensitive Index or simply the SENSEX) is a
free-float market-weighted stock market index of 30 well-established and financially sound companies listed on
Bombay Stock Exchange. These 30 companies are known as Blue chip companies.

Demat Account
Demat account is used to hold the shares purchased in digital or electronic form. During online trading, shares are
bought and held in a Demat account. A Demat account holds all the investments an individual makes in shares,
government securities, bonds and mutual funds in one place. In other words, it is a storage space to hold the shares and
securities purchased.

Trading Account
A trading account is used to buy and sell shares and securities in the stock market. A trading account provide an
interface to buy and sell shares from the stock market. Previously, the stock exchange functioned on the open outcry
system.